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Bankrupt Vallejo May Repay Its Creditors as Little as 5 Percent of Claims

The city of Vallejo, California, proposed paying some creditors as little as 5 percent of what they are owed, making it the first general municipality that would fail to fully repay its debts in bankruptcy.

General unsecured creditors would collect 5 percent to 20 percent of their claims under the plan of adjustment filed late yesterday in U.S. Bankruptcy Court in Sacramento, the state capital.

No city or county has used federal bankruptcy laws to force creditors to take less than they are owed, according to Bruce Bennett, the lead lawyer for Orange County, California, when it filed the biggest municipal bankruptcy in the U.S. in 1994.

Vallejo’s plan assumes the city can’t provide essential services, like police and fire protection, while also paying its debts, he said. Should the city succeed, the case “may become an important precedent,” Bennett said in an interview.

The creditors, who include retirees and former employees, would be paid $6 million over two years. The plan must first be voted on by creditors before U.S. Bankruptcy Judge Michael S. McManus decides whether to approve the proposal.

“While the city regrets that it cannot pay a higher percentage, the fact is that the city lacks the revenues to do so while maintaining an adequate level of municipal services such as the provision of fire and police protection and the repairing of the city’s streets,” Vallejo said in the filing.

Navy Town

The onetime U.S. Navy town of about 120,000 on San Francisco Bay sought protection from creditors under Chapter 9 of the U.S. Bankruptcy Code in May 2008 after the recession eroded tax revenue and unions rejected wage cuts. Chapter 9 allows municipalities to reorganize debt rather than liquidate.

The plan doesn’t alter securities tied to designated revenue sources, such as about $175 million in water revenue bonds, and other special tax obligations secured by special revenue of the city’s restricted funds, according to the documents.

More than 1,000 proofs of claim were filed, including 969 general unsecured claims, 12 unsecured priority claims and 32 secured claims, according to the filing. Claims that listed a specific amount totaled about $479 million, according to the filing. This includes $262 million of general unsecured claims, $45 million of unsecured priority claims and $172 million of secured claims, the filing said.

“It’s unfortunate that we’re not able to do more for our creditors,” Marti Brown, a Vallejo council member, said yesterday in a phone interview. “But if you can’t pay, you can’t pay.”

Challenge Planned

The city said it plans to challenge about $85 million worth of claims submitted by creditors with the goal of eliminating as many as possible. In bankruptcy, claims may be challenged and dismissed either because they are duplicative or because something prevents creditors from collecting.

“Such objections will be both on the merits -- such as the objections to the health care-related claims of retirees -- as well as to claims based on obligations for which the city contends it is not liable,” the city said.

Under the plan, Vallejo will restructure into a single transaction about $46 million of certificates of participation held by its biggest creditor, Union Bank NA, a unit of San Francisco-based UnionBanCal Corp., part of Mitsubishi UFJ Financial Group Inc., Japan’s largest publicly traded bank. Leases on city property that backed the original debt will be consolidated into one lease assigned to Union Bank.

Present Value

The restructuring will decrease the present value of the city’s payments 40 percent by reducing the interest rate and deferring amortization, according to John Knox, a partner at Orrick, Herrington & Sutcliffe LLP, the law firm representing Vallejo that drafted the bankruptcy-exit plan. Union Bank will also keep $6 million of unspent proceeds of the original debt.

A Union Bank spokeswoman, Jane Yedinak, declined to comment on the filing.

Vallejo’s city council in November unanimously approved a five-year budget blueprint that is the basis for the exit plan. The blueprint aimed to pay down $195 million in unfunded pension obligations, trim retiree health-care premiums, curb benefits for new workers and create a reserve fund.

Cities and towns rarely go bankrupt. Orange County lost $1.7 billion from a $7.6 billion investment pool when bets on interest rates soured.

Vallejo filed California’s largest municipal bankruptcy since Orange County. It’s the largest municipality currently in Chapter 9 bankruptcy, said Samuel Gerdano, executive director of the American Bankruptcy Institute, a professional organization that represents lawyers and others in the restructuring field.

The case is In re City of Vallejo, 08-26813, U.S. Bankruptcy Court, Eastern District of California (Sacramento).

To contact the reporters on this story: Alison Vekshin in San Francisco at avekshin@bloomberg.net; Steven Church in U.S. Bankruptcy Court in Wilmington, Delaware, at schurch@bloomberg.net.

To contact the editors responsible for this story: Mark Tannenbaum at mtannen@bloomberg.net; David E. Rovella at drovella@bloomberg.net.

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